If we had the cash, should we put it all into a new or newer rig? Cash is certainly the easiest and cleanest approach, but it is not always the best solution for all circumstances. The answer depends on what other cash requirements we may have: working capital, other equipment needs, emergencies and other investment alternatives.
Conventional financing through a bank is another alternative. Bank rates are generally competitive. However, banks typically are looking to underlying credit-worthiness of the buyer. They are usually not knowledgeable about drilling rigs, their specific uses or lifespan of the equipment. They usually require a significant down payment and may require a relatively short term for the loan in relation to the life of the rig. Some banks may take a long time to get approval through their loan committees. In most cases, a bank loan will go against your line of credit, limiting your options for capital for other cash requirements mentioned above. The drilling rig will appear as an asset on your balance sheet with a debt liability for amount of the loan. The size of the debt may impair your ability to secure other loans. For tax purposes, you may expense depreciation and interest in the year it is accrued.
Leasing offers many types of structures, from pure rental agreements to those with purchase options at the end of the term. The most popular lease-to-own structures are classified as a capital lease or an operating lease. A capital lease has a nominal purchase option, such as $1, at the end of the term and is normally treated as a purchase for tax purposes. An operating lease will usually provide an option to purchase the equipment at the end of the term for the fair market value, to be determined at option time, or for a pre-agreed value, such as 20% of the original equipment price. At the end of a lease, the lessee usually has three options: to walk away; purchase the equipment at the residual amount; or refinance the residual to complete the purchase.
Leasing usually has the lowest up-front capital requirements, in many cases letting drillers get into equipment for first and last payments. An operating lease offers the most flexible terms in length and residual value, allowing lower payments than conventional financing. Although everyone should consult an accountant or attorney, 100% of the lease payment is usually deductible as an expense. A lease should not impair your line of credit at your bank and may not show up as a debt or liability on your balance sheet.
How does the lease process work? Bear in mind most leasing companies are looking for you to own the equipment at the end of the lease. As Will Rogers once said, "The return of my money is more important than the return on my money." So they still want to make sure you can afford the lease payment and that you will hold it through the term agreed upon. The leasing company will evaluate your credit to determine amount of your payments and security deposit. When you are approved and the lease is completed, the leasing company will buy the equipment from your vendor and lease it back to you.
How much rig can I afford? Can I minimize my downtime and maintenance costs? Can I drill more efficiently and do more work in the same amount of time? Can I bid on jobs that are deeper or are in different conditions than I am now able to do? Each of us has a comfort zone as to size of obligations we are willing to take on. A $400,000 purchase may appear to be out of reach if we had to come up with the cash. But it could be one driller's best investment if he/she could pay $6,000 or $7,000 per month and drill at least two more wells than with the current rig. Another driller may find that a used rig at $175,000 could pay for itself in reduced downtime and maintenance costs rather than throwing money at an older machine.
If you are in the market for a new rig, visit with your manufacturer or dealer and evaluate your best financing alternatives. How you pay for your new equipment is almost as important as the decision on the equipment itself. You can get pre-approved for financing to help determine what your monthly payments will be. All it takes is a little time to find out what you can afford and it may be the best time you spend in 2001!